European Securities and Markets Authority calls cryptocurrencies volatile and risky, but innovative
European Securities and Markets Authority calls cryptocurrencies volatile and risky, but innovative By Editor DailyBitcoin Editor

The European Securities and Markets Authority published a report on financial trends and risks.

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Cryptoassets and distributed ledger technology (DLT) topped the European Securities and Markets Authority’s (ESMA) 2021 financial innovation scoreboard, according to a new report

published by the institution.

The 110-page report, titled “Trends, Risks and Vulnerabilities,”

treated cryptocurrencies as a trending financial innovation. But, at the same time, it sees them as a threat to sustainable finance because of their “dizzying” environmental cost, particularly in relation to cryptocurrency mining.

The report suggested that the volatility of cryptoassets, along with the rise of decentralized finance (DeFi), central bank digital currencies (CBDCs

) and stable coins are contributing to increased risk across asset classes.

“Most crypto assets are highly volatile in price and operate outside of the existing EU regulatory framework, raising investor protection concerns,”

the report says.

Risks and volatility

ESMA is an independent European Union (EU) authority tasked with improving investor protection and promoting stable and orderly financial markets. The scoreboard prioritizes financial innovations that require deeper analysis and possible policy responses, and ranks them according to how they relate to ESMA’s objectives.

ESMA’s report was published just as European Union regulators are beginning to prepare for the implementation of comprehensive cryptocurrency regulations, new anti-money laundering (AML) rules and tax reporting requirements for virtual asset service providers and investors. In addition, the European Central Bank (ECB) is set to begin a two-year investigation into the digital euro

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.

According to the report, an increase in risk-taking behavior and market exuberance are to blame for increased volatility in equity markets.

The example of Gamestop

“Increased [risk-taking] behavior has led to volatility in equities (e.g., market moves related to GameStop) and the criThe report said, referring to the recent collapse of New York investment giant Archegos and London-based lender Greensill Capital.

It also refers to what happened earlier this year, when retail investors – united on Reddit –banded together to drive Gamestop’s stock wildly higher, leading to massive losses for new traders as the price eventually collapsed after the initial hype of the move.

“Looking ahead, we expect to continue to see a prolonged period of risk to institutional and retail investors from additional, possibly significant, market corrections and to see very high risks across the ESMA landscape,” the report said.

The report warns about the risks surrounding crypto assets, adding that crypto market capitalization fell nearly 40% in May, highlighting its high price volatility.

Restrictions on stablecoins

The report suggests that the European Union’s forthcoming Markets in Cryptoassets (MiCA) regulatory framework is designed to address these risks described above. The comprehensive framework will apply across 27 states and includes particularly severe restrictions on stablecoins, including a requirement for stablecoin issuers to hold at least 3% of stablecoin reserves.

The report reiterates that stable currencies are not the darling of the European Union.

“Market developments around private stable currencies continue to come under scrutiny from global regulators, given the potential impact that mass adoption of stable currencies could have on financial systems. This call for greater transparency and legal certainty has been reinforced as Tether, the largest stablecoin, provided a breakdown of its reserves for the first time in May 2021,” the report said, referring to Tether revealing that 49% of its reserves were made up of unspecified commercial paper.

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The EU’s stance on stable currencies became clearer when, last week, ECB President Christine Lagarde said that, in her view, stable currencies pretended to be currencies and were actually assets.

Environmental costs

The energy consumption of certain DLT protocols is a source of environmental concern, the report said.

“Innovation can support sustainability by addressing information gaps through green financial technology (FinTech) solutions, but the environmental cost of one particular innovation, cryptocurrencies, is skyrocketing,” the report said.

“Estimates vary An, but agree that the carbon footprint of cryptocurrencies is far from negligible,”the report said. “These developments trigger discussions about possible regulatory responses to the unintended consequences of innovation, and in particular crypto mining.”

Financial innovation

Along with innovations such as artificial intelligence and machine learning, the report emphasized the proliferation of distributed ledger technology (DLT ), DeFi and central bank digital currencies, CBDC.

“DeFi has the same benefits as the Blockchain technology on which it is based, namely disintermediation, 24-hour availability and resistance to censorship. Italso faces similar challenges and risks, including in relation to operational resilience, scalability and governance,” the report said.

It goes on to say that CBDCs and the use of stablecoins, combined with increased interest in crypto assets from institutional investors, are blurring the boundaries between traditional centralized financial systems and DeFi, and therefore “increase the risks of potential spillover of DeFi risks to the real economy.”

“These risks are further intensified by the rapid growth of DeFi and the recent price performance of major crypto assets,” the report said.

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The growing risk to investors could be putting pressure on regulators to intervene across the EU, according to the report, which said, “Regulators’ engagement with FinTech through innovation hubs and regulatory constrained environments is becoming common across the EU, with benefits for both sides.”

Fintech

Fintech innovation hubs are operating efficiently, the report suggests, adding that all member states have at least one hub set up. Regulatory sandboxes are less common, with eight currently operating in the EU, including Denmark and the Netherlands.

“Regulators and innovators alike increasingly recognize the benefits of innovation hubs and regulatory sandboxes, i.e., stimulating innovation while remaining alert to emerging risks,” the report says.

In addition to the risks involved, DLT has the potential to improve efficiency in financial processes and businesses while improving consumer outcomes, the report says, adding that applications are still limited.

“Scalability, interoperability and cyber resilience will require monitoring as DLT develops. Other challenges include anonymity, as well as governance and privacy issues, ” the report said.

Sources: ESMAa>, Coindesk, archive

Translation and version by DiarioBitcoin

Image by Unsplash